Chapters

Chapters

Lesson 04 / 05

In this lesson

Index adjustment and coupon payments
Coupon, real yield and price
The maturity floor
Index, currency and expense fit

What inflation-linked bonds protect

Follow the contract’s specified index into its payments, then separate that protection from market price, tax and the cost of your own goal.

The fixed rate can pay a changing amount.

Hypothetical US TIPS: $1,000 original principal, fixed 2% annual coupon rate, semi-annual payments. The applicable payment-date index ratio is assumed, not today's inflation.

Original principal$1,000× index ratio 1.03 ↓
Adjusted principal$1,030× 2% ÷ 2 ↓
Half-year cash coupon$10.30

At ratio 1: $1,000 → $1,000 → $10. The base changes; the rate stays fixed. Principal adjustment is not an immediate cash payment.

US Treasury Inflation-Protected Securities use a specified consumer-price index; deflation can reduce the adjusted base. Check the reference months and publication dates: which period’s prices does today’s adjustment reflect? If the reference prices come from earlier months, indexation can lag a change in today’s prices. Other countries use different indices and protections. Linkage promises no stable market price.

Check the index, lag and deflation terms

TreasuryDirect identifies the US CPI measure used to adjust TIPS principal. Deflation can reduce adjusted principal and subsequent coupons; the original-principal floor applies at maturity.

A positive coupon need not give a positive real yield.

Real yield connects purchase price to indexed payments relative to the specified index. Paying more reduces it; a positive coupon can accompany a negative real yield. Nominal-bond YTM and TIPS real yield use different bases.

Nominal results depend on the index path and cash flows. Higher required real yields can lower price despite rising adjusted principal, with substantial duration sensitivity.

Negative yields, reinvestment and a changing price

TreasuryDirect documents negative real yields, including at auction. A price can imply purchasing-power loss against the specified index before costs/taxes despite positive coupons. YTM’s holding, payment and reinvestment assumptions still apply; indexation and market repricing act simultaneously.

The floor names original principal, not your purchase cost.

Separate purchase example: $1,080 paid

$1,000 original principal$80 premium

At maturity → greater of original $1,000 or adjusted principal

The bar divides purchase cost. The $80 premium is outside the floor; coupons and adjustments still affect the total result. The floor protects neither an early sale price nor fund-unit purchase cost.

Timing, costs and tax still affect results. A fund owns securities; you own units at current value. An imminent bill still needs reliable funding.

Which inflation is protected?

Housing or care can rise differently from a specified basket even in the same currency. Dollar payments indexed to US prices leave exchange-rate risk for euro spending; display currency changes neither mismatch.

Read deflation terms, coupon/principal adjustments, maturity-only protections and local tax timing. Tax recognition and cash receipts need not coincide. Put duration, currency and access beside the intended role.

Keep the household expense and local rules separate

Currency movements can offset or amplify nominal receipts in spending currency; index matching is a separate issue. Check when deflation affects coupons/principal and whether the floor applies only at maturity. Do not export US rules to another investor/account: tax and the cash paid out can follow different schedules.

Check your understanding

Try each question, then check your answer.

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Buying above original principal

You pay $1,150 for TIPS with $1,000 original principal. Ignoring coupons, what does the original-principal floor at maturity protect?

The $1,000 original principal, not necessarily the $1,150 you paid.
Every investor's full purchase price, including any premium.
The market sale price before maturity.

Show the explanation

Correct answer: The $1,000 original principal, not necessarily the $1,150 you paid.

The TIPS maturity provision compares adjusted principal with original principal. A premium paid by a later buyer is a separate cost and is not the amount named by that floor. The provision also does not fix the market price available if sold earlier.

Return to the explanation

Dollar payments and euro care

A bond adjusts payments using a US price index in dollars. Your future expense is euro-denominated care. What mismatch can remain?

Only currency, because both the US index and care costs measure rising living expenses.
Both exchange-rate changes and differences between the index and the care cost.
Only the care-price path, because indexation already compensates for exchange-rate movements.

Show the explanation

Correct answer: Both exchange-rate changes and differences between the index and the care cost.

An index represents a specified basket and method. Care costs can move differently, while dollar payments must be converted for euro spending. Indexation addresses the contract's defined measure; it does not automatically hedge every household expense or currency.